Energy Sector

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The Energy sector ranks eighth out of the ten sectors as detailed in my Sector Rankings for ETFs and Mutual Funds report. It gets my Dangerous rating, which is based on aggregation of ratings of 20 ETFs and 94 mutual funds in the Energy sector as of July 17, 2014. Prior reports on the best & worst ETFs and mutual funds in every sector are here.

Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the sector. Not all Energy sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 23 to 167). This variation creates drastically different investment implications and, therefore, ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst ETFs and mutual funds, which allocate too much value to Neutral-or-worse-rated stocks.

To identify the best and avoid the worst ETFs and mutual funds within the Energy sector, investors need a predictive rating based on (1) the stocks ratings of the holdings, (2) the all-in expenses of each ETF and mutual fund, and (3) the fund’s rank compared to all other ETFs and mutual funds. As a result, only the cheapest funds with the best holdings receive Attractive or better ratings. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.

Investors should not buy any Energy ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long historyof not paying off. Here’s the list of our top-rated Energy stocks

Figure 3 shows that 11 out of the 356 stocks (only 2% of the market value) in Energy ETFs and mutual funds get an Attractive-or-better rating. At the same time, zero out of 20 Energy ETFs and zero out of 94 Energy mutual funds get an Attractive-or-better rating.

Investors need to tread carefully when considering Energy ETFs and mutual funds, as the sector is littered with Dangerous-or-worse funds. No ETFs or Energy mutual funds in the Energy sector allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Investors would be better-off investing in individual stocks.

CVR Energy Inc. (CVI) is one of my favorite stocks held by FENY and earns my Attractive rating. Since 2009, CVI has grown profits (NOPAT) by 35% compounded annually. Over the same time period, the company increased return on invested capital (ROIC) from 10% in 2009 to 18% in 2013, which is in the top quintile of all companies I cover. The company has continued this growth into 2014 and investors have taken note via the 27% increase in CVI’s stock price since February. The good news for investors is that CVI still remains undervalued. CVI’s current price of ~$49/share gives the stock a price to economic book value (PEBV) ratio of 1.3. This number implies the company will never grow NOPAT more than 20% above its current level. This expectation seems too pessimistic considering that CVI has been growing profits by 35% compounded annually for the last 4 years. We believe CVI will exceed the expectations implied by its current price.

ConocoPhillips (COP) is one of my least favorite stocks held by Energy ETFs and mutual funds and earns my Dangerous rating. Over the past six years, COP’s NOPAT has declined by 9% compounded annually while the company’s ROIC has fallen from 8% to 6%. Also, COP has generated negative economic earnings for four of the last five years. Despite COP’s weak history, the stock price is up over 30% since February, mainly on the back of strong quarterly earnings reports. This run up in the stock price has caused COP to become overvalued. To justify its current price of ~$81/share, COP would need to grow NOPAT by 5% compounded annually for the next 11 years. A 5% compounded annual NOPAT growth rate may not seem high, but COP has not seen more than two consecutive years of profit growth since 2007. Market expectations look overly optimistic compared to this company’s lack of profit growth in the past.

186 stocks of the 3000+ I cover are classified as Energy stocks.

Figures 4 and 5 show the rating landscape of all Energy ETFs and mutual funds.